With fluctuating market trends, construction costs and financing rates, the choice is far from clear cut. Read on for helpful ROI insights from three industry experts — an owner, an operator and a brand executive.
Owner
“I have always thought that yesterday was the best time to build,” said Rupesh Patel, partner at Verakin Capital, citing the historical trajectory of construction costs and the importance of being ahead of the curve. Despite temporary price escalations during the worst of the COVID era, he noted that costs remain similar due to labor increases offsetting any drop in material prices.
In Patel’s view, taking the initiative to build today primes you for the future. “When it comes to divesting out of hotels, institutions will always look at the newest assets in markets as the most attractive,” he said, adding that a hotel that is five years old today will be a decade old in five years—so, in essence, the earlier you begin, the better.
As debt markets tighten and interest rates rise, attention must be paid to financing. Patel emphasized the need for creativity and due diligence, along with avoiding delays and extra costs.
The top determining factors for when to build a hotel are market performance, construction costs and financing costs. He warned against the cheapest construction path, highlighting that poor quality may lead to a less satisfying guest experience and potential issues when trying to divest.
When it comes to identifying the best opportunities for building hotels, Patel points to “pocket markets,” or areas that haven’t seen new hotels for several years and whose existing supply is aging.Developers can find local officials eager for new projects and can reap the benefits of having the newest, most attractive property in town.
However, every opportunity comes with challenges. For Patel, the most significant obstacles include lead times and equipment availability. “In some cases, we have been told lead times are over 18 months, which does not fit into our typical build schedule of 14 months,” he said.
Now is the time to build, Patel said but success requires early planning and a careful balance of costs, financing and market conditions.
Operator
Will Woodworth, VP of investments for private equity management firm Peachtree Group, is clear and optimistic about the opportunities the current building market presents. Now is the time to build, he said.
He pointed to the declining supply pipeline and shrinking average annual additions to supply as a golden opportunity. For groups able to locate prime sites and navigate the complexities of capital markets, now is the time to act. “There is a clear opportunity for groups that can find compelling sites and navigate debt and equity capital markets to break ground on new projects—to find themselves, two years from now, with the best and newest hotel in a market and with limited competition from other new entrants,” Woodworth said.
To determine when to build, Woodworth said the two most important factors to consider are the existing occupancy rates in the market and the growth trends in average daily rate. “Given the high development cost, it only makes sense in markets where achieving high ADRs looks achievable, coupled with quick absorption of the new rooms to drive cash flow.”
Woodworth pointed to submarkets with limited recent supply additions as prime building opportunities. However, challenges are prevalent in the current climate. The most significant hurdle is locating markets where ADR growth has managed to outstrip construction cost increases—“where post-pandemic growth has lagged and has left certain markets impossible to pencil, while net in-migration to other markets has yielded new opportunities—both in existing submarkets and in new areas where there was no demand to drive a new hotel development.”.
Despite these headwinds, Woodworth asserts that viable projects will continue to find their way.
Brand
Mark Williams, managing director of franchise development at Extended Stay America, echoes the sentiments from his counterparts.
“This is the right time to build an extended-stay hotel,” he said, pointing to a demand boom that outweighs current supply in many markets. Despite an uptick in supply over the past year, extended stay rooms make up only 9.5 percent of total available room nights, according to the 2023 U.S. Extended Stay Hotels National Report by The Highland Group.
Williams acknowledged that while the cost of capital is high, waiting for rates to become more favorable could mean missing out on prime opportunities. “Keep in mind that when your new hotel opens, there will be opportunities to refinance at more reasonable rates—but more importantly, you’re also able to focus on generating market share of the extended-stay guest,” he said.
When asked about the key factors determining the right time to build a hotel, Williams emphasized the importance of location and market growth potential. “Extended-stay hotels rely on high occupancy from long-term travelers which will streamline the operating model, simplifying the labor management and improve the bottom line,” he explained. The best opportunities, according to Williams, lie in regions experiencing population and business growth, including secondary and tertiary markets. Sectors like supply chain, manufacturing, construction, education, military and healthcare can drive demand for extended-stay hotels in these areas.
However, Williams acknowledged challenges exist, notably securing financing for hotel construction projects and coordinating effectively with contractors. Here, he stressed the value of partnering with a franchise brand that has a proven business model for extended stay hotels and offers support to developers.